NIGERIA: OIL COMPANIES SHARE CONCERNS WITH DOE A/S

S E C R E T SECTION 01 OF 05 ABUJA 001575

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E.O. 12958: DECL: 07/24/2017
TAGS: ENRG EPET ECON PREL
SUBJECT: NIGERIA: OIL COMPANIES SHARE CONCERNS WITH DOE A/S
HARBERT

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Classified By: Economic Counselor Necia Quast for reasons 1.4 (b & d).


1. (C) SUMMARY: Gas exploration is necessary to meet supply
commitments for both export and domestic use and the
Government of Nigeria (GON) should provide adequate fiscal
terms for international oil companies (IOCs) to invest in gas
development for domestic use, according to IOCs Total, Shell,
Chevron, and ExxonMobil. IOCs observed significant progress
in building local capacity, but meeting Nigeria's ambitious
local content goals would be difficult. Both Nigerian
National Petroleum Corporation (NNPC) and IOCs advocated an
increase in Nigeria's OPEC quota to accommodate new oil
production capacity. Insecurity in the Niger Delta had
increased cost margins and limited IOCs ability to find
quality oil services contractors. The GON had pressured IOCs
to invest in Nigeria's refining sector, but high GON
subsidies for domestic fuel made private investment in
refining uneconomic. END SUMMARY.


2. (SBU) U.S. Department of Energy Assistant Secretary for
Policy and International Affairs Karen Harbert on July 17 met
with the Nigeria managing directors of international oil
companies (IOCs) Total ) Jacques Marraud-des-Grottes, Shell
- Basil Omiyi, Chevron - Andrew Fallthrup, ExxonMobil - John
Chaplin, and separately with Nigerian National Petroleum
Corporation (NNPC) Group Managing Director Funsho Kuplokun
and senior NNPC staff to discuss the oil and gas sectors in
Nigeria.

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Gas Exploration Essential for Myriad Supply Commitments
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3. (C) Meeting gas commitments would require comprehensive
exploration for Nigeria's ample undeveloped gas reserves. A
senior NNPC official indicated NNPC was considering gas
exploration and told A/S Harbert that it would be difficult
for Nigeria to develop its gas reserves as fast as proposed
gas export projects, underscoring that Nigeria had previously
only found gas when looking for oil and had never engaged in
gas exploration. Kupolokun assessed Nigeria had 7 trillion
cubic feet (Tcf) of gas, but 38% of this was restricted in
gas cap formations and would not be extractable until their
constituent oil reservoirs had been depleted.


4. (C) The task of committing gas supplies for both export
and domestic use led some industry observers to question
whether Nigeria would have sufficient gas to meet its supply
obligations. Total rep Jacques Marraud-des Grottes dismissed
this as a misconception, stating instead that the constraint
would be accessible gas supplies. Just as Nigeria had
implemented Production Sharing Contracts (PSCs) for offshore
oil development, Nigeria needed a framework for gas
exploration to determine how the GON and IOCs would share gas
stocks and proceeds.


5. (C) The IOCs noted that developing Nigeria's gas
resources, and subsequently the terms under which gas
supplies were sold to the domestic market, would be a
material factor in the long-term development of Nigeria's
domestic power sector. As of July, IOCs had plans for four
gas export schemes in Nigeria: new liquefied natural gas
(LNG) terminals Brass LNG and OKLNG; the expansion of the
NLNG project; and Chevron's gas-to-liquids (GTL) plant at
Escravos. Given Nigeria's domestic energy crisis, however,
both the IOCs and Kupolokun acknowledged that the GON might
require IOCs to commit a percentage of their total gas
supplies to the heavily-subsidized domestic market, which the
IOCs assessed would affect the pricing structure of gas
currently exported at world prices.


6. (C) An NNPC official suggested that the administration
and legislature were working on implementing several key
reforms including the Downstream Gas Act, a revision to
Nigeria's gas fiscal scheme, and the Gas Master Plan. An IOC

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suggested that IOCs had more allies in the new Nigerian
National Assembly than in the NNPC.

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Fiscal Terms Key to Developing Gas
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7. (C) The IOCs asserted that Nigeria's fiscal environment
would impact heavily future gas investment. NNPC underscored
that inadequate GON funding for joint venture (JV) oil
project increased project costs, and the IOCs lamented that
the GON did not understand their JVs' true funding
requirements. Shell opined that the NNPC erroneously thought
IOCs could cheaply supply gas to the domestic market. The
IOCs contended that issues Nigeria's gas framework should
address included securitization of GON payments for
domestically-supplied gas, domestic energy pricing,
accounting rules for gas investment, and incentives for
developing deep water gas reserves.

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Securitization
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8. (C) ExxonMobil rep John Chaplin reported that the real
cost of power generation in Nigeria from many privately owned
diesel power generators was very high, but lamented a
perceived public unwillingness to pay incremental increases
for electricity from the grid. He decried the GON's
procrastination in gas and power sector reform and payment
securitization. Shell defended the GON's financial position
noting that the Nigerian Electric Power Authority's (NEPA)
successor companies had inherited collection problems, citing
an improving current collection rate of 60%. He believed the
new government was committed in one form or another to
carrying out former President Obasanjo's stalled plans to
meet IOCs' securitization demands, but questioned whether the
Nigerian public would pay market prices for power. One IOC
noted that a lack of political stability in Nigeria made it
more difficult for IOCs to secure credit for large investment
projects. Delays inherent to operating in Nigeria meant
deepwater projects that typically take 3 to 4 years to
complete elsewhere take 10 years in Nigeria, requiring
stability over several governments.

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Subsidies and Taxation
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9. (C) While the GON's high subsidies for domestic energy
consumption discouraged private gas investment, Shell
estimated that limited capacity rather than the gas price
drove the electricity tariff, advocating that the GON offer a
declining capacity charge subsidy to replace the subsidized
electricity tariff. Another IOC noted that while GON had
gradually increased gas pipeline transportation tariffs, most
IOCs could not develop gas economically at the subsidized
rate. As of July, the Yar'Adua administration was in the
process of formulating a more thoughtful process to increase
the transportation tariff to encourage IOC gas investment


10. (C) For gas investment amortization and taxation rules,
a senior NNPC official advocated departing from the
Associated Gas Framework Agreement (AGFA) that allowed IOCs
to recover 85% of gas development costs against upstream oil
income. This practice amounted to selling subsidized gas
abroad in the midst of Nigeria's domestic energy crisis. The
official stated Nigeria must protect gas future revenue and
apply any subsidies to the domestic market. Nigeria's new
gas fiscal regime allowed the GON to collect additional taxes
on gas investments, implementing an escalator provision when
a gas project matured. One IOC asserted that despite the
GON's negative attitude towards AGFA, IOCs would not consider
investing in independent power projects (IPPs) without it.


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Progress on Meeting Tough Local Content Requirements
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11. (C) NNPC officials reiterated to A/S Harbert Nigeria's
commitment to local content requirements in the upstream
sector. The IOCs said Kupolokun's policies had boosted local
content and significantly expanded local engineering
capacity. IOCs were making progress on meeting GON local
content goals; the GON had set ambitious local content
requirements which pressured IOCs to "go as fast as
possible," but probably realized they might not be met.
Local content requirements were enforced inconsistently by
different GON ministries and a lack of high level ministerial
coordination made it difficult for IOCs to meet these
requirements.

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OPEC Quota Allocation Insufficient
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12. (C) Both NNPC and the IOCs contended that Nigeria's OPEC
oil export quota was insufficient, especially as IOCs worked
to meet Nigeria's oil production capacity target of 4 million
barrel-per-day (b/d) by the end of the decade. This issue
especially concerned IOCs who recently saw Nigeria reduce oil
exports from 2.4 million b/d to 2.1 million b/d to shoulder
OPEC production cuts. The NNPC was cutting production from
offshore fields governed under PSCs as opposed to production
from its JVs because GON revenues from JV projects were
higher than those from the offshore PSCs, which enjoyed
project cost-recovery against current oil revenue streams.
NNPC officials said how to allocate production cuts and
accommodate exploration and new production were a subject of
bitter debate within NNPC and the GON.


13. (C) One IOC opined that Nigeria could either cheat on
its OPEC quota or constrain deepwater development. The
latter would cost Nigeria $10 billion in foregone oil
revenues and send a major negative signal to potential
investors. The GON previously had made a failed case for
OPEC to increase Nigeria's oil production quota based on
expected production capacity increases, but both NNPC and
IOCs recognized that a stronger case should be based on
socio-economic grounds.

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Concerns with U.S. Bill
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14. (C) NNPC officials expressed concern with the "NOPEC"
bill, which the U.S. Senate and House of Representatives had
passed. A/S Harbert shared DOE's position that while the
U.S. condemned cartel activity, it assessed the bill - which
would deny sovereign immunity from U.S. judicial action to
any foreign state engaging in hydrocarbon cartel activity -
would have negative implications for the worldwide oil
market. She assuaged fears that the bill's implementation
was imminent.

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IOCs Shun Recent Bid Rounds
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15. (C) IOCs had chosen not to participate in Nigeria's last
two bid rounds for oil blocks. Firms who had offered huge
signature bonuses in exchange for oil blocks would soon see
it difficult economically to develop their blocks. It would
take several years for the industry to recognize errors in
the licensing process and IOC investment in new licenses
would be dry in the interim. Both the GON and bidders
expected unrealistic returns from new blocks and some bidders
based projects' economic viability on target oil prices that
were too low.


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Niger Delta Insecurity Hits Contracting Capacity
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16. (C) A/S Harbert inquired at what point IOCs would assess
the increased security costs of operating in the Niger Delta
to outweigh the benefits. Both NNPC and IOCs believed that
decreased oil services industry contracting capacity in the
Niger Delta was a significant indirect cost. NNPC observed
insecurity had reduced competition amongst oil services
providers; that production costs had escalated 50% to 60%
above expected levels; and insecurity had exacerbated the
effect of robust worldwide oil industry activity had on
contractor rates. Shell sensed that NNPC knew the balance
sheet costs of insecurity but downplayed it by using the
below-market GON budgeted oil price to price losses in
representations to the GON.


17. (S) All companies had experienced difficulty in finding
qualified contractors to work in the Delta, and conceded that
the quality of contracting work on its oil production
facilities had suffered and could impact future production.
While Total's relationship with local communities had been
good, in January it tightened its security posture in
response to an attack on one of its Port Harcourt-area
housing compounds in December 2006. As a result, most
dependents were evacuated. Total had previously only used
security consultants and local police for physical security,
but now relied chiefly on Nigerian Joint Task Force (JTF)
forces. Chevron reiterated to A/S Harbert the deleterious
effect of illicit oil bunkering on its operations and
requested U.S. Government assistance in tracking bunkering
barges and tankers.

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Fuel Subsidies Deter Capable Refinery Investment
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18. (C) As of July, Nigeria imported all refined petroleum
product as its refineries were not operating. NNPC, which
publicly opposed the recently aborted sale of the Port
Harcourt and Kaduna refineries to a domestic consortium, said
domestic fuel subsidies remained an issue. One IOC opined
the domestic consortium had offered a fair price for the Port
Harcourt and Kaduna refineries, based on the GON taking off
the domestic fuel subsidy.


19. (C) IOCs confirmed that NNPC wanted them to invest in
oil refining and did not consider the domestic or Chinese
companies who held concessions for Nigerian refineries to be
capable of running them properly. The GON subjected IOCs to
an economic double standard, looking for IOCs to shoulder
refining projects that were uneconomic for other firms. The
IOCs had agreed to study the possibility of investing in
domestic refineries, but would only participate if the
projects were economical. The GON as of July had awarded
sixteen licenses for new refineries, but none of these
projects had begun implementation, largely because domestic
fuel prices are still controlled. IOCs would be loath to
build a new refinery without considerable benefits; a 200,000
b/d refinery would cost $4 billion to build. The rep
suggested some Chinese or Indian firms would be willing to
bid for Nigeria's refineries if the GON lifted the domestic
fuel subsidy, but potential labor, environmental, and
community issues would deter IOC investment in existing
refineries.

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COMMENT
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20. (C) The GON is going full-bore on domestic energy sector
reform, but has not yet provided the legislative or
regulatory framework necessary to court IOC investment to
develop gas resources for domestic use and power generation.

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IOCs appear willing to invest in Nigeria's gas, refining, and
power sectors given economic returns, but the GON struggles
to provide the necessary incentives. Given Nigerians'
perceived sense of entitlement for subsidized fuel and
electricity, the GON is forced to serve two masters in
implementing domestic energy policy.
GRIBBIN